Monday, May 25, 2009

Are there opportunities in today's markets? I believe there are if you know where to look. A distinguishing aspect of American culture is how we react to adversity. Many people see the turmoil in the markets as a sign of gloom and disaster. Certainly, people have seen their 401K's shrink in value and retirement dreams dashed. Others, however, see opportunities in this chaos.

We believe greater opportunities exist among small cap stocks rather than in the large or mega-cap segments of the market. To test this thesis, we examined the Standard & Poors 1500. This composite index is representative of the the overall market. Our examination presents our findings for both the median value within the index and the mean value for a variety of measures. Admittedly, a fuller study would have segmented this index into deciles. Neither time nor resources allows me that luxury.

Summary

The median stock price of the S&P 1500, as of May 22, 2009 is $20.09 and the mean stock price is $24.52. The median EPS (TTM) is $1.18 and the mean EPS (TTM) is $0.37 which provides us with a median P/E of 17X and a mean P/E of 66X, respectively. Using another measure, Enterprise Value to EBITDA, we find the median EV/EBITA to be 12.5X and the mean -5.8X; indicating the market weighted mean has a negative EBITDA.

Data

Median

Mean

Price

$20.09

$24.52

Shares Outstanding (Average Q1)

71.80

237.10

Equity (common) Q1

$843.40

$3,162.43

Average Net Income (5 Yr)

$74.30

$383.02

Market Value of Invested Capital

$3,261.88

$20,700.61

Total Assets Q1

$2,429.80

$17,847.26

Average EBITDA (5 Yr)

$154.98

$785.34

Sales (TTM)

$1,683.60

$7,061.77

Number of Employees

4,704.00

18,757.39

Operating Margin (TTM)

7.85%

3.00%

Return on Equity (TTM)

9.80%

2.39%

Free Cash Flow (TTM)

$0.98

$1.05

Goodwill & Intangibles Q1

$201.70

$1,829.37

Average Return on Assets (5 Yr)

5.14%

5.87%

Total Liabilities Q1

$1,369.30

$14,460.02

Earnings Per Share (TTM)

$1.18

$0.37

Cash From Operations (TTM)

$194.80

$1,028.29

Net Income (TTM)

$59.50

$112.70

Sales (TTM)

$1,683.60

$7,061.77

Multiples

Median

Mean

PE

14.30

22.73

PE - Average 3 Years

19.40

26.04

PE - Average 5 Years

20.10

25.71

PE - Average 7 Years

20.20

24.41

Price/Book

1.51

2.50

Price/Book - Average 3 Years

2.35

3.27

Price/Book - Average 5 Years

2.39

3.13

Price/Book - Average 7 Years

2.32

2.91

Price/Sales

0.86

1.37

Price/Sales - Average 3 Years

1.49

2.23

Price/Sales - Average 5 Years

1.55

2.31

Price/Sales - Average 7 Years

1.51

2.27

Price/CFPS

11.65

16.78

Price/CFPS - Average 3 Years

16.60

19.91

Price/CFPS -Average 5 Years

17.00

19.75

Price/CFPS - Average 7 Years

17.10

19.27

Price/FCFPS

13.70

28.49

Price/FCFPS - Average 3 Years

22.70

33.52

Price/FCFPS - Average 5 Years

24.15

32.53

Price/FCFPS - Average 7 Years

22.90

30.96

Ratios

Median

Mean

Gross Margin (TTM)

37.75%

41.25%

Gross Margin - 5 Year Average

37.60%

40.85%

Operating Margin (TTM)

7.85%

3.00%

Operating Margin - 3 Year Average

10.50%

12.35%

Operating Margin - 5 Year Average

10.50%

13.48%

Return on Equity (TTM)

9.80%

2.39%

Return on Equity - 5 Year Average

12.60%

13.52%

Return on Equity - 7 Year Average

11.80%

11.86%

Return on Invested Capital (TTM)

8.20%

5.84%

Return on Invested Capital - 5 Year Average

9.20%

8.50%

Growth

Median

Mean

Cash Flow - Growth 12M

-11.70%

-53.67%

Cash Flow - Growth 1 Year

0.00

-38.12%

Cash Flow - Growth 3 Years

5.85%

-1.67%

Cash Flow - Growth 5 Years

9.40%

6.33%

Cash Flow - Growth 7 Years

9.60%

7.05%

Free Cash Flow - Growth 12M

1.20%

15.88%

Free Cash Flow - Growth 1 Year

-0.95%

1.09%

Free Cash Flow - Growth 3 Years

5.90%

6.43%

Free Cash Flow - Growth 5 Years

4.40%

5.04%

Free Cash Flow - Growth 7 Years

8.05%

6.68%

Net Income - Growth 12M

-19.55%

-57.09%

Net Income - Growth 1 Year

-7.10%

-44.07%

Net Income - Growth 3 Years

2.05%

-2.80%

Net Income - Growth 5 Years

8.65%

6.06%

Net Income - Growth 7 Years

10.60%

8.16%

Sales - Growth 12M

2.90%

4.51%

Sales - Growth 1 Year

7.20%

8.65%

Sales - Growth 3 Years

10.20%

12.28%

Sales - Growth 5 Years

11.30%

14.43%

Sales - Growth 7 Years

9.70%

12.20%

My analysis of the above referenced data draws me to conclude that smaller companies represent better investment opportunities than the large and mega-cap components of the S&P 1500. Important measures of growth, most particularly cash flow and net income, show that small companies, as presented in the median, show better prospects than their big brothers. These smaller companies also show strong measures of profitability over the long term. Not insignificantly, the smaller companies are selling at significant discounts to the large companies and do so for both short time periods and over the long haul.

Disclosure: At the time of writing this article, the author holds positions in small cap, mid-cap and large cap companies.